1991 reloaded

T. C. A. Srinivasa-Raghavan
In the 22 years since the last major crisis, the economy is right back where it started.
Finance Minister P Chidambaram has said he can see some green shoots in the Indian economy. Of late it has been as barren as Caesarâ€™s wife Calpurnia.
GDP growth has come down from around 9 per cent to well below 6 per cent in a scant three years.
Investment is hugely down, from 38 to 26 per cent of GDP, and no amount of pulling on the corporate udder is getting it to yield milk.
Inflation remains high, around 13 per cent for consumers who are sullenly waiting to get rid of Soniaâ€™ Sorry Army.
The current account deficit has just gone well above 6 per cent which could lead to foreign money withdrawing from India.
And political uncertainty engulfs the country like the January fog in Delhi.
Is it any wonder that the economy is not taking off?
The imminent crisis
It is the job of finance ministers to hold out hope. After all, they can hardly say that the end is nigh.
But governors of central banks have to be more circumspect. That is probably why Governor Subbarao spoke very guardedly about the green shoots during his I G Patel Memorial Lecture at London School of Economics.
This is what he said: â€œâ€¦There is nothing inevitable about the India growth story. We can accelerate growth and improve welfare only if we effectively implement wide ranging economic and governance reforms. Slipping up on this will amount to a costly and potentially irreversible squandering away of opportunities.â€
He then went on to discuss inflation, governance and the current account of deficit. Having some inkling of how much the current account deficit is â€“ and has been â€“ worrying policymakers for the last one year, I paid particular attention to the last bit.
The labour did not go unrewarded. Dr Subbarao shot down a straw man which he had himself set up. â€œâ€¦the marginal propensity to import by borrowing money is smallâ€, he told the audience.
If I may respectfully ask, Sir: who ever said there was a link between the two? As far as I know, this is how it works. People borrow more when interest rates come down. They then spend more.
Some of that extra spending gets translated into imports. Without those imports, the extra demand would get translated into higher prices. It is as simple as that.
But India being India, we seem to have got both now â€“ higher inflation and higher imports. Add lower exports and what you have is something very worrying, a looming balance of payments crisis which could happen at the drop of a foreign hat.
The only remaining hope is strong â€“ very strong â€“ government action to bring down the fiscal deficit which, as Dr Subbarao said, is a governance problem.
â€œThe complexity,â€ he said, â€œarises from the political economyâ€¦ political executivesâ€¦much more tempted by short-term political pay offs rather than long-term sustainability.â€
He then concluded his speech thus: â€œThe India growth story is not inevitable. It will not materialize in the absence of vigorous and purposeful structural and governance reforms. It is those reforms that must continue to engage our attention.â€
The question is if we can have those reforms without a crisis. History says we canâ€™t.
The reform of agriculture happened because of the successive droughts of 1965 and 1966 after which India was reduced to begging America for food.
The slow reforms of the mid-1980s in the financial sector happened because the so-called â€˜Hinduâ€™ rate of growth forced them on the government. As S S Tarapore, former deputy governor of the RBI, once put it, there were over 200 rates of interest in the economy. Simply reducing the rates at the short end was a major reform.
The big bang reforms of the 1991 happened because Rajiv Gandhi â€œwas much more tempted by short-term political pay offs rather than long-term sustainabilityâ€ and landed the economy in a mess that was inherited by his successor, V P Singh.
And make no mistake. The current set of reforms is also happening because a crisis is looming.
Two decades ago, Manmohan Singh started off by getting the economy out of very deep trouble. He may well end his career by landing it right back into it.
Such is life.http://www.thehindu.com/business/Economy/1991-reloaded/article4567419.ece?ref=sliderNews

Joseph Hellerâ€™s Catch-22 remains one of the literary classics of the 20th century. Set during the course of the Second World War, the book gave a new phrase to the English language. As a paragraph from the book goes:

There was only one catch and that was Catch-22, which specified that a concern for oneâ€™s safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didnâ€™t, but if he were sane he had to fly them. If he flew them he was crazy and didnâ€™t have to; but if he didnâ€™t want to he was sane and had to.

Orr is a bomber pilot who keeps getting shot down. He has been shot down 17 times, which is more than anyone else in his unit. Given that, he is deemed crazy to still be flying. All he has to do to be grounded is to ask. But the catch is that the moment he asks he would no longer be deemed to be crazy. He would be sane and being sane he would have to fly more missions.

This catch was the Catch-22. Over a period of time such a hopeless no-win situation of the kind Orr was in came to be referred in the English language as a Catch-22.

The Indian economy is currently in a Catch-22 situation. The government of India had a total expenditure of Rs 7,12,671 crore, during the course of 2007-08. This grew by nearly 44 percent over the next two years and during the course of 2009-10, the total expenditure of the government stood at Rs 10,24,487 crore.

Increasing expenditure is not a problem if its met by increasing income. But that wasnâ€™t the case here. Between 2007-08 and 2009-10, the revenue receipts of the government (or the income that the government hopes to earn every year) grew by a minuscule 5.7 percent to Rs 5,72,811 crore.

Some part of the increase in expenditure was met by selling shares that the government held in public sector companies. But a major part of the increase was met by simply borrowing more. The borrowings and other liabilities of the government shot up from Rs 1,26,912 crore to Rs 4,18,482 crore, a massive jump of nearly 230 percent, during the period.

The good part of this massive increase in government expenditure was that the Indian economy continued to grow at very high rates, even though economic growth in large parts of the world was slowing down in the aftermath of the financial crisis that had erupted after the investment bank Lehman Brothers went bust in September 2008.

The Indian economy grew by 8.6 percent in 2009-10 and 9.3 percent in 2010-11. And Indian politicians opened their champagne bottles and told us that India had decoupled from the global economy. As Sajjid Chinoy of JP Morgan writes in Business Standard: â€œThe charitable (but incorrect) interpretation is that India successfully decoupled from the global economy, returned to its nine percent growth path post-Lehman.â€

The formula seemed to be working and so the government continued with it. For 2012-13, government expenditure was expected to come in at Rs 14,30,825 crore. This meant that expenditure more than doubled between 2007-08 and 2012-13. This, when revenue receipts of the government went up by around 61 percent to Rs 8,71,828 crore, during the same period.

The borrowings and other liabilities of the government during the same period went up by 310 percent to Rs 5,20,925 crore. The government borrows money to make up for the difference between what it earns and what it spends. This difference is referred to as the fiscal deficit.

If the economic growth rate of 2009-10 and 2010-11 was anything to go by the Indian economy should have continued to grow at the same pace, given that the government was spending more and more money.

But that did not turn out to be the case. Numbers released on 28 February 013 suggested that the Indian economy grew by 4.5 percent during the three-month period ending on 31 December 2012. This was the lowest in 15 quarters.

So what happened that led to the economic growth rate falling by half? Initially, the increased government expenditure translated into economic growth. As the government spent more money, those who got that money benefited. They spent that money on goods and services, and this translated into higher economic growth. But two other things happened as well.

As the government went around spending more it led to higher inflation. More money chased the same amount of goods and services leading to higher prices. Food inflation rose at a much faster pace than overall inflation.

Higher prices meant that people were spending more to meet their regular expenditure. And this meant lower savings. In the year 2009-10 the household savings stood at 25.2 percent of GDP. In 2011-201, household savings had fallen to 22.3 percent of GDP. Even within household savings, the amount of money coming into financial savings (i.e. bank deposits, life insurance funds, pension and provident funds, shares and debentures) fell at a faster rate.

As the Economic Survey 2012-13 pointed out: â€œWithin households, the share of financial savings vis-Ã -vis physical savings has been declining in recent yearsâ€¦Financial savings accounted for around 55 percent of total household savings during the 1990s. Their share declined to 47 percent in the 2000-10 decade and it was 36 percent in 2011-12. In fact, household financial savings were lower by nearly Rs 90,000 crore in 2011-12 vis-Ã -vis 2010-11.â€

So we have a situation were the government has been borrowing more and the overall household financial savings have come down. When the government borrows more it â€œcrowds outâ€ and leaves a lower amount of savings for banks and other financial institutions to borrow from. This leads to higher interest rates on deposits and hence higher interest rates on loans.

Higher interest rates, to some extent, have killed economic growth as people have bought fewer homes, cars, consumer durables, etc. Corporates have also postponed their expansion plans. So increased government spending, which drove economic growth between 2009-11, has now pulled it down, as interest rates as well inflation have remained high.

So does this mean that government expenditure needs to be cut? Yes and no. If interest rates and inflation have to come down, government expenditure and hence borrowing need to come down. But with the private sector and households going slow on spending money, if government expenditure is also cut, it will slow down economic growth even further. So thatâ€™s the Catch-22 situation that the Indian economy has been put in.

As Chinoy puts it,â€œA tightening fiscal and slowing growth are seen as coincidental. Markets applaud fiscal discipline, but bemoan weak growth. But these are not independent phenomena. Instead, they are inextricably linked. Fiscal austerity impinges upon growth. A reduction in the deficit has a contractionary impact on activity.â€

In fact this can already be seen in the Indian context. During the second half of 2012-13, the government cut down on expenditure as it feared a downgrade by international rating agencies. The targeted expenditure for the year stood at Rs 14,90,925 crore. It was revised to Rs 14,30,825 crore, which was 4 percent lower. And this has had an impact on economic growth. â€œOn a cyclically adjusted basis, Indiaâ€™s deficit was reduced by a whopping 1.5 percent of GDP in 2012-13 â€“ largely by squeezing expenditures. No wonder the slowdown was accentuated further,â€ writes Chinoy.

Getting out of this Catch-22 situation is difficult. It makes immense sense for the government to cut down on expenditure. Only that can drive down interest rates and inflation and thus revive â€˜genuineâ€™ economic growth. But that, of course, will take time to happen and meanwhile economic growth will slow down further. Given that Lok Sabha elections are due next year, it is not hard to figure out what the government is likely to do.

The governmentâ€™s targeted expenditure for 2013-14 is at Rs 16,65,297 crore, which is 16.4 percent higher than the last financial year. Given this a scenario of high inflation and high interest rates is likely to continue in this financial year as well. And that is no April Foolâ€™s joke.

The Green Shoots of recovery allegedly seen some time ago by eagle-eyed scouts in the finance ministry were a mirage. Yesterday, all the numbers to emerge on the economy were negative.

The combined output of eight core sector industries â€“ which account for 38 percent of the Index of Industrial Production (IIP) â€“ fell 2.5 percent in February. This is a first since 2005.

The HSBC India Manufacturing Purchasing Managersâ€™ Index (PMI) contracted from 54.2 to 52 in March. This suggests that the slowdown has extended to March.

The automobile numbers â€“ with car sales falling more than a fifth in March 2013 despite record discounts â€“ confirm this downtrend, with some companies reporting jaw-dropping declines. Tata Motors skidded 67 percent and Ford 42 percent in cars.

The anecdotal evidence, if anything, confirms this.

Aviation is in the doldrums, with ticket prices being discounted heftily to drum up sales. The business of getting â€œbums on seatsâ€ is a bummer right now despite Kingfisher being knocked out of the market.

Real estate is in a mess â€“ as the recent default ratings on companies such as HDIL suggest. Home buyers are simply not interested in buying at inflated prices.

The power sector is in deep red. The oil sectorâ€™s losses have not diminished one bit, despite the so-called decision to raise diesel prices. Coal output is struggling to revive.

Telecom is in deep water â€“ as the court cases involving the sectorâ€™s giants and the industryâ€™s inability to raise tariffs suggest.

Exports showed a small sign of revival in February, but the year is ending in negative territory.

Despite a faltering economy, the current account deficit (CAD) has hit an all-time-high of 6.7 percent in the December quarter of 2012.

The countryâ€™s is living on borrowed time and borrowed money â€“ Rs 67,000 crore of foreign portfolio investment has flowed in this year in equity and debt. Without this, the rupee would be even lower than it is.

Business Standard thinks the external crisis is big enough for the country to approach the International Monetary Fund (IMF) for a loan even when we have more than $290 billion in foreign exchange reserves. The logic: you get better terms if you go when you are not yet in deep crisis.

The country has changed every law to suit foreign capital (GAAR, Mauritius investors), and even now the finance minister is on a roadshow to Japan to get investments. Says the BS editorial: â€œIfâ€¦the threat of an external crisis is indeed major, and sufficiently so that it is dominating the thinking of policy makers, it is worth wondering why, instead of placating international capital, the government doesnâ€™t just go to the one-stop window for such problems: the International Monetary Fundâ€¦â€.

In early February, when the Central Statistical Office predicted GDP growth in 2012-13 at 5 percent, the governmentâ€™s soothsayers went into denial.

Montek Singh Ahluwalia of the Planning Commission pooh-poohed the CSO, and said: â€œI think it (growth projection of 5 percent) is very low. I have been told that CSO has taken data from April to November (2012-13) and they just projected it (advance estimates).â€

Wonder what Ahluwalia will say now.

And C Rangarajan, Chairman of the PMâ€™s Economic Advisory Council, claimed his â€œown estimate is (that) when the full year data becomes available, it (GDP growth) can be revised upward.â€ Reason? â€œThere is definitely a change in the investment climate. It will pick up in the fourth quarter. When actual data come, GDP growth will be 5.5 percent or more during the current financial year.â€

Well, the actual data will come shortly when the IIP is released in the next couple of days. A part of it already shows negative growth. One wonders if the 62 percent of IIP outside the core sector will grow so fast as to drown out the negative 2.5 percent growth in the core sector.

This writer believes that Indiaâ€™s climb out of the trough will be slow and painful. We are unlikely to see a sustained revival â€“ barring a short election-related burst â€“ before UPA-2 bows out.

It may also be time to relabel the term Hindu rate of growth as the secular rate of growth. The UPA inherited an economy about to hit 9-9.5 percent growth with inflation at half that rate.

It is now looking at the exact opposite situation: growth at 4-5 percent, and inflation in double-digits.